How Yale’s Endowment Negotiates Fees

Vanderbilt Hall stands on the Yale University campus in New Haven, Connecticut, on June 12, 2015 (Photo credit: Craig Warga/Bloomberg).

Over the weekend, Yale Universitys investment office
released its annual report, which combined a detailed
examination of the endowments fiscal year performance
with an emphatic defense of active management  and a
revealing look at how it negotiates fee payments with
managers.

The
report blasted critics of high-fee investment options like
hedge funds and private equity, arguing that
Warren Buffett, Malcolm
Gladwell, and other fee bashers overemphasized
gross fees to the detriment of net returns.

While investing in a passive index strategy would have
resulted in lower fee payments by Yale over the past thirty
years, it would have resulted in dramatically lower net
returns, the report stated. An index approach...
would shortchange Yales students, faculty, and staff, now
and for generations to come.

Still, while CIO David Swensen and his team are willing to
pay for performance, they wont agree to just any terms.
According to the report, the investment office negotiates
fees and terms throughout the endowment portfolio. The
endowment sets performance hurdles for each investment strategy
and structures its partnerships so incentive fees are
only paid when external partners outperform their benchmarks on
a net basis.

All domestic equity managers, for example, must beat a set
hurdle before they can receive performance fees, and the
majority also earn lower management fee rates as firm assets
grow. Meanwhile, most foreign equity managers face hurdle rates
combined with a rolling incentive fee structure aligned
with an appropriate long-term investment horizon.

As for hedge funds, Yale said just 5 percent of its absolute
return managers still earn the traditional 2-and-20 fee
structure. The rest have agreed to superior
arrangements, including management fees below 2 percent,
performance fees under 20 percent, and hard hurdle
rates.

In real estate, the endowment said it leverages its
favorable position as a lead investor in the
universitys real estate partnerships to negotiate
fair terms for all limited partners, including
annual fees to offset firm overhead, hard preferred
returns of 5-6 percent, and carried interest of 20 percent.

But in venture capital and leveraged buyouts  where
Yale invests almost a third of its portfolio  the
investment office admitted to having limited bargaining
power, as the overwhelming demand for high-quality
managers reduces the ability of limited partners to influence
deal terms.

Even in these asset classes, however, Yale said it
negotiates for fair terms including fee offsets and
clawback protections.

The endowment returned 3.4 percent for the fiscal year,
compared with an 11.5 percent return for fiscal 2015. The
average college endowment fell
2 percent last year.

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